Bond Preview:

A split on the next direction for debt securities

By

DanielF. Floyd

WASHINGTON (CBS.MW) -- Analysts are divided about likely activity in the fixed-income market next week. Some contend that bond prices likely will be dictated by the stock market, while others insist that Treasury notes and equities could fall out of line with one another.

Ken Mayland of ClearView Economics believes that bonds will follow stocks next week. The "very strong" ISM survey, with price component above 60, is an indication that the pricing environment has changed.

Friday's employment report was consistent with economic growth in the third quarter. Coming in the wake of recession and recovery the report is consistent with the fall of bond prices, but this has not actually occurred because stock prices have been so weak, he explained.

Bonds have been seen as a haven, so capital has been going into fixed income market. Strength in bonds was temporary because a big rally in stocks could turn the tide: money may start flooding out of bonds and into stocks.

As far as next week's economic indicators are concerned, Mayland sees a strong recovery in the manufacturing sector, with industrial production up 0.4 percent and capacity utilization rising 0.2 percent.

Retail sales will appear soft because the report follows strong numbers. Sales should edge up 0.1 percent; excluding autos, the figure should be about 0.3 percent.

The retail sales report will pose a key question for investors: Is the consumer faltering? "This question is good for bonds" because it points to a slower economic recovery.

With regard to other indicators, business inventories will not have much impact on markets. Jobless claims probably will bounce back up 20,000-25,000, Mayland said.

Markets may continue to consolidate next week, according to Tony Crescenzi, a bond market analyst with Miller, Tabak & Co.

When markets move sharply in either direction, those that sold short may try to book profits. Investors, who have been shying away from stocks, may buy them next week because their prices are lower. Many investors may have sold off Treasury notes on Friday because they believed prices had peaked out, Crescenzi explained.

Many important reports will be released next week, which may offer a mixed picture of the economy. The import/export price index will get more attention with dollar down. A weaker dollar means higher inflation; imports will be more expensive.

Meanwhile, the producer price index probably will be flat. There should be some weakness in the retail sales report, which could lead investors to believe that consumer spending is declining.

With the initial jobless claims report, people will watch for a confirmation of the improvement seen in the employment report on Friday.

Overall, the key issue next week will be corporate confidence. How well major firms perform will be at the "forefront of investors' minds," Crescenzi said. See economic forecast and calendar

Stocks and bonds may cease to move in opposite directions

While the economic environment suggests improvement, investors are daunted by disappointments at a micro level, claimed Kenneth L. Hackel, chief U.S. fixed income strategist at Merrill Lynch.

Stocks continue to languish, partly due to fears that a weakening dollar will lead to reallocations by foreign investors and hedge funds. Also, equities may be discounting the positive economic news because of a widespread belief that stocks are fundamentally overvalued, especially as attentions have turned to credibility issues about past profits and future earnings potential.

"Bonds can and should start to decouple from trends in equities, and respond to the growing body of fundamental evidence supporting a move to higher interest rates and tighter credit spreads," he said. Improved customer demand and widening profit margins should have a greater impact on a company's ability to service its debt than the market's decision to assign higher or lower earnings multiple to its stock price, Hackel explained.

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